By now, most investors are likely aware that Congress is once again in the midst of a partisan battle that could result in a shutdown of the Federal Government or a breach of the U.S. debt ceiling and potential default. The possible consequences for investors are difficult to predict; few observers believe there will be a shutdown, and almost nobody thinks the U.S. will default on its obligations. Nobody, however, can say with certainty how we’ll avoid such outcomes.
In addition to perennial debates about federal taxation and spending, this year’s battle includes an effort by some Republican lawmakers to defund, or delay the implementation of, the Affordable Care Act (ACA), key provisions of which go into effect on October 1. Having failed to topple the law either via the 2012 elections or through Supreme Court challenges, these lawmakers are hoping to use the federal budget process or the debt ceiling debate to forestall or eliminate it.
What follows are some common questions investors have about the showdown, and some answers to help put it all into perspective.
Q: Why is this happening now?
A: The federal government faces two distinct but politically connected deadlines. First, a short-term bill, known as a “continuing resolution,” (CR) that has funded the federal government since Congress failed to pass a 2013 budget last year, expires on Monday, September 30, the last day of fiscal 2013. In the absence of a new budget or CR to fund the government, much of it will have to shut down. Second, the Treasury’s legal authorization to borrow money to pay the government’s bills reaches its limit, the so-called debt ceiling, in mid-October, according to the Treasury Department.
Q: What’s the difference between a budget and a CR?
A: Let’s start with the CR. Congress and the President are supposed to use a process delineated in the Budget Act to establish spending, revenue and borrowing levels for the government. Under this process, the President first submits a budget request to the House and Senate. Those two bodies debate it and, through a deliberative process, establish their own budget framework. Hiccups and missed deadlines have long plagued the process, but in recent years, intense partisan divides have ground normal budget-setting procedures to a halt, so Congress has been funding the government by voting to continue previous spending “authorities.” The U.S. Government Accountability Office (GAO) has found that funding the government increasingly through continuing resolutions produces serious uncertainty and inefficiencies, since many departments don’t know how much they’ll be able to spend in a given year, and may not have the authority to fund high priority new projects.1
Q: So why doesn’t Congress just pass another CR?
A: On September 20, the Republican-controlled House of Representatives passed a continuing resolution that would keep the government’s lights on through mid-December (when, presumably, a new showdown would occur) but deny funding for discretionary portions of the ACA. The next stop for the CR is the Democratic-majority Senate, where it has essentially no chance of survival as long as it de-funds the President’s signature achievement. We appear likely to see a slew of procedural, largely symbolic efforts by the more conservative of the Senate’s 46 Republicans, but they simply don’t have the numbers to prevent the majority from stripping out the defunding provision, passing the CR, and sending it back to the House for a vote. Passage in the Senate is expected on Sunday, September 29, possibly leaving only hours for the House to either pass the stripped-down CR, or let government funding expire.
Q: Will the House pass a stripped-down CR?
A: That is the $16 trillion question. Many House Republicans, either out of principle or the fear of a primary challenge from the right in the next election, have vowed not to vote for anything that provides funding for the ACA. The Speaker can either choose to add some kind of provision to the bill (besides defunding the ACA) that attracts a Republican majority and can pass in the Democratic-led Senate, or call a vote on the Senate bill as it stands, hoping that enough Republicans join Democrats to pass it.
The latter scenario is the likely outcome and is approximately the strategy that kept us from going over the fiscal cliff and passed the current CR earlier this year. Following this path would earn the Speaker much Republican ire. He could, however, try to justify breaking the so-called “Hastert Rule” in this way by encouraging his party to use debt ceiling debate in a few weeks to try to defund or delay the ACA.2
If Congress can’t pass a CR in this way, a government shutdown probably follows. Incidentally, a shutdown would not itself defund or delay the ACA, as mandatory spending, not annual appropriations, fund the healthcare law’s exchanges and subsidies.
Q: What’s the debt ceiling, and what happens if we breach it?
A: Every day the federal government spends more money than it brings in and makes up the difference with borrowed money. A statutory limit has placed restrictions on the total federal debt since the 1917 passage of the Second Liberty Bond Act. At the time, the Act placed an $8 billion limit on the amount of government bonds that can be issued. Congress has voted to raise the limit more than 100 times since 1917, and the practice has usually been treated as a formality, given that the debt limit covers spending for programs and functions that Congress has previously approved.
Recent attempts to raise the debt ceiling have grown contentious, however, with fiscal conservatives demanding spending cuts or other concessions in order to consent to lifting the cap. At present, some of these lawmakers hope to use the debt ceiling, which the U.S. should hit in mid-October, as a point of leverage to force the delay or de-funding of the ACA. As was the case in 2011, if the debt ceiling is not raised, eventually the Treasury will not be able to meet the government’s obligations as they come due. While the Treasury can prioritize spending so as to continue to pay interest on the national debt for some time, it is conceivable that if the debt ceiling is not raised, the U.S. could miss an interest payment—in other words, default.
A U.S. default would be unprecedented (although a technical glitch once caused a delayed interest payment). Consequences could include a credit rating downgrade that forces Treasury investors to sell their holdings, and higher interest rates across a broad swath of debt instruments, thanks to a change in the market’s perception of U.S. creditworthiness. Suffice it to say, breaching the debt ceiling is a dangerous and potentially very costly course for the U.S.
Q: What makes this standoff different from the last few?
A: During the 2011 showdown over the debt ceiling, the economy was weaker than it is now and both deficits and the debt-to-GDP ratio were higher. The threat of a debt ceiling breach sent markets into a nosedive and led to a credit rating downgrade, which was partially due to lawmakers’ apparent inability to maintain U.S. creditworthiness. There was, however, a measure of consensus among the parties that debt reduction measures were necessary, and over the ensuing year and a half, Congress implemented measures, such as the Budget Control Act, the American Taxpayer Relief Act and the sequester, which purport to deliver $4 trillion in deficit reduction and stabilize the debt-to-GDP ratio over the next 10 years.
Today, the economy is in better shape than it was in 2011, but there is less consensus about the need for additional spending cuts and less yet for further tax hikes. Indeed, the current impasse centers not on debt and deficit levels, but on the healthcare law. Whereas negotiations helped end recent showdowns, Republicans are now divided over whether even to try to torpedo the health care law. The President has ruled out any negotiation whatsoever with respect to the debt ceiling.
Q: What are the odds of a government shutdown or a breach of the debt ceiling?
A: Most lawmakers and market observers, myself included, believe that Democrats and centrist-tending Republicans will find an eleventh-hour compromise, as they did during the “fiscal cliff” negotiations last winter, to avoid a government shutdown and debt ceiling breach. Such a compromise could, however, be politically fraught for the House Leadership, since it could expose them and their allies within the Republican Party to primary challenges from the right. What makes a compromise most likely, ultimately, are the possible political consequences of allowing a shutdown or debt ceiling breach to happen.
Q: What does the showdown mean for investors?
A: It’s understandable why the popularity of Congress hovers, according to a poll released earlier this year, well below that of head lice, meth labs and the Kardashians.3 Hating one’s government is, however, not an investment strategy. While I don’t expect the current brouhaha to precipitate a financial crisis, investors should expect potential volatility over the next few weeks. Bear in mind that in 2011, the S&P 500 Index lost about 17% of its value during the debt ceiling debacle, including almost 7% on Monday, August 8, following the credit rating downgrade.4 In the end, Congress raised the debt ceiling and the U.S. did not default. And investors had one of the great buying opportunities of their lifetimes.
The S&P 500 Index is a broad-based measure of domestic stock market performance. The index is unmanaged and cannot be purchased directly by investors.
- U.S. Government Accountability Office, “Effects of Budget Uncertainty from Continuing Resolutions on Agency Operations,” March 13, 2013.
- The Hastert Rule refers to and informal principle of former Speaker of the House Denis Hastert, who would not allow a vote on a bill unless a majority of the majority party supported the bill.
- Public Policy Polling, “Congress somewhere below cockroaches, traffic jams, and Nickelback in Americans’ esteem,” January 8, 2013.
- Bloomberg, September 24, 2013.
Past performance does not guarantee future results.